Cold Feet - Investing for Retirement

[Cubswin]

Create a budget to figure out exactly what you monthly costs will be. What city are you going to be living in? This will make a huge difference in the amount you will be able to contribute.

At a bare minimum, I would take full advantage of the employer match and contribute enough each month to max out a Roth IRA. Ideally you would want to max out your 401k as well, but this may not be obtainable based on your current salary and your fixed monthly cost such as housing, car payments, and other expenses.

The key is to start early as compounding returns are your friend. Have you contributions auto-deducted from your paycheck as you will avoid the temptation to touch these funds.

[IdealFugacity]

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Start out putting LOTS into the 401K and into a Roth in addition (Roth does have some additional flexibility as folks have already mentioned--which can be a bad thing if you are the type who can't resist spending money you have simply because you have it). You will then develop spending habits and a budget that fits within your takehome paycheck. Do the opposite, and start out without much in the 401K and you may find yourself spending everything you earn simply because it's there. Depends on your personality.

No matter what, if they have 401K matching, contribute enough to max that out. Otherwise you're just giving up free money. So if they match up to the first 6%, put in AT LEAST 6%.

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The part about getting a salary I am looking forward to the most by far is figuring out a proper asset allocation (Stocks, Bonds, Cash) and then subdividing the equities part (Large Cap, Small Cap, Foreign), and watching my money grow. I do not think spending money simply because I have it will be a problem. If there is anything I am concerned with, it is the options I will have in my 401k, which I hope will be able to help me 'automatically' set up a large chunk of my investment allocation.

[f97tosc]

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1. I put $100 into a savings account pre-tax. It grows at 8% for 20 years, and then I withdraw it and pay 25% income tax.

My total withdrawl = (100 * 1.08^20) * .75 = $349.57

2. I make $100 and pay 25% income tax. I put the remaining money in a savings account making 8% for 20 years, and withdraw it tax free.

withdrawl = (100 * .75) * 1.08^20 = $349.57

Obviously I have simply regrouped the terms on the left side of the equation. Can someone tell me what, if anything, I'm missing about the "magic of compound interest?"


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First of all, your calculation shows something that is true and important to realize, namely that a standard IRA (1) is basically equivalent to Roth IRA (2), if the tax brackets are the same (and we also disregard certain other differences in the rules).

However, if you put the money into a regular savings account, not IRA, then you have to tax the interest every year. If your interest was 8%, and you taxed 25%, then you would effectively only make 8%*75%=6% interest per year. You would get $100*75% *(1.06)^20=240.54. Quite a difference!

Now it should be noted, that if you buy stock that grow and stick to them for the long term, then you will get much of the same benefit since you don't get capital gains tax until you sell them. However, the compound principle above would still apply to the dividends, or any time you wanted to trade your stock for some other investment. In an IRA you can do this without triggering taxes.

[wdcbooks]

I think people are missing something in their advice. The great majority of younger workers who invest in their 401k do not hold that account until retirement. They draw it out, either by taking loans they do not repay, or by cashing the plan out when they leave their employer. They don't do this because they are all dumb and irresponsible.

People do it because they lack the savings to buy a home, to weather a period of unemployment, to go back to school. I think it is great that the OP is able to put 8% away, but I wouldn't dedicate all of my disposable income to retirement, or even a Roth in his situation. I would work to build up a reserve of cash in addition to his retirement savings. This will actually benefit him in retirement by making sure that he is able to keep those funds and not spend them on the inevitable unexpected things life brings.

[IdealFugacity]

To be able to purchase a $400k home in 5 years, with the 10% down payment rule (or is it 20?!), this would require $418.31 a month in a TAXABLE account growing at 9% yield (compounded monthly to minimize the work i did in excel, rough-and-dirty). Actually, probably a *whole lot* more because this is before taxes.

This seems like a painful number. Again, I have literally no clue how much my monthly expenses will be yet, but I can't add on both hands how many things I have to account for if life runs perfectly:
(Car payment if I get a small, 5-6k loan to supplement my savings to purchase, car insurance, gas, taxes/etc on paycheck, rent, all the deductions from paycheck, student loans!, etc)

[maxtower]

It is far better to make budget sacrifices in your twenties to save for retirement than it is to hold off and try to catch up in your 30s and 40s.

As for the house, buying a 400,000 house in 5 years is going to be tough. You won't be able to afford the payment (2500+maintenance) even with a 10% down payment unless you get some substantial raises. I wouldn't worry about saving that much in a taxable account for the house. You'll most likely be looking in the 200k - 250k range unless your salary really takes off. Of course you could always get some roommates. [img]/images/graemlins/smile.gif[/img]

[IdealFugacity]

Well, I don't think I'd be buying a 400k house unless I was married.

Now, a 200-250k house, with a 10% down, would be $210-$261 a month at 9% APY compounded monthly. That's seems more reasonable. But still, with taxes, I'd have to have a very aggressive portfolio [probably kept as a separate allocation altogether from my retirement portfolio, right?] and get a little lucky. But, now that I think about, putting away 400 dollars a month for the goal of having a nice house is probably a worthwhile investment.

I bet you guys can't wait until mid-July, when I've arrived at a rough figure for a months expenses (August and September probably be more accurate than the first month) and then January/February when the rent is no longer $0/month. My post count will be as high if not higher than that it is now, geez.

[Supersetoy]

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People do it because they lack the savings to buy a home, to weather a period of unemployment, to go back to school. I think it is great that the OP is able to put 8% away, but I wouldn't dedicate all of my disposable income to retirement, or even a Roth in his situation. I would work to build up a reserve of cash in addition to his retirement savings. This will actually benefit him in retirement by making sure that he is able to keep those funds and not spend them on the inevitable unexpected things life brings.

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I find this advice to ring very true with me.

Me: 24 years old, graduated college at 22 - hired on at 45K a year, now in the mid 50K range.

My recommendations: Right now, I think the most pertinent thing for you to do is to STOP renting. Renting is worse (IMO) than buying a brand new car (depreciating asset) because you're throwing all of that money away.

It would be in your best interest to find a property that you can afford. I've found that I can happily survive when my "bills" (mortgage/utilities/insurance etc.) take up 60% of my monthly income (after tax and a 10% 401K pre-tax deposit). I also haven't had a car payment since I was 18, and pay off my credit cards in full every month.

After purchasing a property - and all the needed appliances/etc., I found myself left over with a 2 month "emergency fund" left over. This however, doesn't include the $20K between my Roth and 401K after 2 years - don't know if this was mentioned - but at any time you can take the principal contribution amounts from a Roth tax free. IMO this works just like a savings account I wouldn't want to touch. But if I ever needed it in an emergency situation, I could take it. I believe that maxing out my Roth every year is the best thing I can do for my retirement. I am doing my own investing (now through Zecco.com nonetheless) and have an average yearly return of 14% (even including the markets recent crash).

I've been in my property for a full year now (it took living with the parents for 5 months to build up enough savings) and already it has appreciated 17% (Seattle).

I'm still struggling to build that "6 month emergency fund" because I want it all in liquid cash. But I'm currently at a "4 month emergency fund" and that's assuming I continue paying all the same bills (some of which really are luxuries).

But everything is very stable - I have no fear of losing my job and really the only emergencies I could think of realistically is the health of myself and my family, and a possible car accident.

Welcome to the working world though - it's a lot more mundane IMO than college, but the cash flow definitely gives you a lot more opportunities during your free time.

[IdealFugacity]

Every 6 months for the first three years I could potentially have to move. Purchasing is not really an option.

[theTourne]

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Can someone tell me what, if anything, I'm missing about the "magic of compound interest?"

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You're not accounting for paying taxes each year on the portion of your 8% which is subject to taxation (i.e., capital gains, dividends).

So, if that resulted in an average after-tax return of 7% per year in your taxable account, it would grow to ~$290 in the 20 years.

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Thanks for the response. I should have been more clear. I was intending to compare a Roth IRA with a traditional IRA, so capital gains/dividends wouldn't be an issue.